Enhancing firm level competitiveness Indian leather and footwear industry

Strategies and Road Map Development A Report for NMCC August 2009

Contents

Foreword Background Objective and approach Setting the Context : Overview of global and Indian leather industry Indias share of global leather exports Market composition Segment composition Sub-segment composition Key conclusions for Indian leather and footwear sector Tracing the evolution of leather industry in India and China Analysis of the Indian Leather Industry and key conclusions Factor Conditions Demand Conditions Firms Structure and Rivalry Supporting Industries Government Support Scenario Analysis Key Conclusions and Recommendations Annexure: Results of the Primary Survey List of Abbreviations Contacts

3 5 6 7 9 11 14 15 19 22 26 27 37 41 51 54 59 61 67 82 83

NMCC have undertaken a number of studies towards enhancing the competitiveness of manufacturing sector and identify the current strengths and constraints of keysectors, and recommend national level industry/ sector specific policy initiatives

Background

The National Manufacturing Competitiveness Council (NMCC) has been set up by the Government to provide a continuing forum for policy dialogue to energize and sustain the growth of manufacturing industries in India. In this context, the NMCC have undertaken a number of studies towards enhancing the competitiveness of manufacturing sector including identification of manufacturing sectors which have potential for global competitiveness; current strengths and constraints of identified sectors, and recommend National level industry/sector specific policy initiatives as may be required for augmenting the growth of manufacturing sector.

Deloitte Touche Tohmatsu India Pvt. Ltd. (Deloitte) have been engaged by NMCC to study and submit a report for enhancing the Firm Level Competitiveness (Strategies and Road Map Development) for the Indian Leather and Footwear sector. This document is the subsequent sections details the Deloitte report on Firm Level Competitiveness (Strategies and Road Map Development) for the Leather and Footwear sector in India.

August 2009

Objectives and approach

The objectives of the Deloitte engagement were Understand the competitiveness of firms across their supply chain From the results for organizations in each sector, identify the key areas for focus for the organizations based on the critical trends and factors driving success From the above, provide the contours for strategic initiatives and detail a roadmap for implementation. Approach Analyze the performance of organizations based on data obtained through primary and secondary research.

In addition to the primary/secondary research of organizations, Deloitte conducted primary research with key stakeholders and experts. The objective was be to validate the inputs from secondary research and obtain a perspective on the critical success factors and drivers for competitiveness of the sector. The results from the above were then be aggregated and analyzed to understand the Gaps in their performance with reference to the sector objectives defined by NMCC. Recommendations based on the Gaps identified focusing on the key areas for consideration in each sector and a road map to achieve the sectoral objectives.

The results from the above were then be aggregated and analyzed to understand the Gaps in their performance with reference to the sector objectives defined by NMCC.

Setting the context: Overview of global and Indian leather industry

Leather Sector - Global The global leather trade was valued at around US$100 bn in 2005. Organizations in the developed economies source leather products from developing economies directly or through intermediaries while focusing on building brands.
Leather Companies Companies in fashion and accessories segment Suppliers to Brand Owners

LVMH, Gucci, Nike, Adidas etc

Kasen Holdings, Yueyuen and numerous SMEs

USA, Western Europe Leading Footwear Clusters in addition to India

China, India and other developing countries

1 Vietnam / Indonesia OEM production Focus on low costs segments mainly for the European market 2 China OEM production Focus on low costs segments mainly for the US market 3 Romania Production subsidiaries of Italian companies Focus on lower to medium price range

4 Italy Design, marketing & production of premium shoes Export widely to the world market 5 Portugal Production Focus on short-production runs in the medium price range 6 United States Design and marketing Focus on specific market segments like sports and recreational shoe and boots Manufacturing only in selected lines such as handsewn casuals shoes and boots

Source: ITC Leather Statistics, 2005 August 2009 7

Leather Sector Global : Weaknesses and Threats for Leading Clusters

Country Portugal Romania Italy China Vietnam Indonesia United States

Weakness Predominantly catering to European markets

Threat Competition from Chinese and other low cost countries

High cost of labor Low value, high volume products Predominantly a footwear manufacturer (esp. Sports shoes) Unstable political system , currency depreciation forcing out companies from Indonesia High cost of labor

Rising exports from the low cost countries Tariff barriers on Chinese exports by the European Union Tariff barriers on Vietnamese exports by the European Union Rising costs due to raw material imports, flooding of the domestic market by Chinese manufacturers Virtually no manufacturing of shoes except for defence units.

Source: The Global Footwear Industry , http://www.fibre2fashion.com/news/general-textile-industry-news/vietnam/newsdetails.aspx?news_id=64666

Classification of Leather & Footwear Industry

Leather and Footwear Industry

Finished Leather

Leather Footwear

Leather Garments / Apparel

Leather Goods

Source: Classification based on International Trade Center- Geneva

Leather from bovine animals are called hides and leather from sheep, goats, lambs and kids are called skins The raw material for the leather industry are hides and skins which originate from livestock. The raw hides and skins are converted into finished leather in a tannery.

Finished leather is the input material for leather products like footwear, bags, gloves, garments etc. In addition to the core value chain, there are allied industries like footwear components, product machinery etc. which have an influence in the performance of the leather and footwear segment.

Indias Share of Global Leather Exports Indias share in the global exports is 2.2% occupying the 9th position. China is the largest exporter of leather with a share of over 31% of worlds exports
Indias composition of exports in Leather and Footwear (mn USD) 2007-08 105.81 45.9 1% 1% 1.4% 1.4% 1.4% 1.6% 1.7% 1.8% 1.8% 1.9% 343.99 2% 2.2% 2.2% 2.6% 2.7% 2.8% 3.2% 15.7% 3.4% 4% India Korea Thailand Portugal Indonesia Netherlands Romania UK Viet Nam Malaysia Austria Argentina Pakistan Others Composition of World Exports Average: 2001 - 2005

12.4% 766.93

31.9%

784.95

1163.82 266.11

Finished leather Leather footwear Footwear components Leather garments

Leather goods Saddlery and harness Non-leather footwear

China Italy Germany Brazil Spain Belgium United States of America France

The composition of world exports is a five year average (2001 to 2005). Share of India and China are calculated on the basis of the average value of exports during the period 2001 to 2005. Intra-country trade between China, Hong Kong, Macau and Taiwan have been taken into account while arriving at the market share.
Source: CLE, ITC

August 2009

Indias share in world leather trade had been in the declining trend from 8.8% in 1981 to 2.6% in 2006, whereas China has increased its share from 0.41% in 1981 to around 31% in 2006 Worlds production of shoes with leather uppers grew by 30% between 1979 and 1996. During this period production rose in developing countries by 160% and their share of global output grew from 35 to71%
China India comparison - World leather trade 10 31%

6 % of world trade

0 1978-81 China India Source: China and India: Economic Performance, Competition and Cooperation - An Update - T. N. Srinivasan 2004 Data from 2005-2006 is collected from ITC, Comtrade websites 1982-84 1985-87 1988-91 1992-94 1995-97 1998-00 2000-06

10

Market Composition
Composition of India exports Average : 2001 - 2005 11.2% 13.8% 1% 1% 1.2% 1.2% 1.4% 1.5% 1.5% 1.6% 2% 2.1% 2.3% 2.6% 3% 3.1% 11% Italy Germany China UK USA Spain France Source : ITC Netherlands Portugal United Arab Emirates Korea Belgium Denmark Australia 11.4% Canada Viet Nam Malaysia South Africa Others USA Japan Russian Federation Germany UK Canada 8% 9.5% Italy Korea Netherlands France Australia Spain Viet Nam Kazakhstan Belgium Panama United Arab Emirates Others Composition of China exports Average : 2001 - 2005 14.7% 42.4%

1% 0.7% 0.9% 1.2% 1.2% 1.2% 1.1% 1.5% 1.2% 1.9% 2.4% 5.7%

13.7%

6.9%

12%

51% of Indian exports are to Italy, Germany, China and the UK. However, these countries account for only 27% of world imports of leather. USA is the single largest importer consuming nearly 27% of total world imports. Indias exports to USA forms just 11% of its overall export value. Even within Indias top export destinations, Indias share in their import portfolio is around 4%, while Chinas share is around 9% - 15% in these regions.

Composition of World Imports Average : 2001 - 2005 15.0% 1.0% 0.9% 1.0% 1.1% 1.3% 1.2% 1.3% 1.5% 1.7% 2.2% 2.2% 2.4% 2.7% 5.2% 5.9% 5.9% 7.5% 5.9% 7.4% 26.9%

USA Italy Germany France China UK Japan Spain Belgium Netherlands Canada Mexico Austria Korea Romania Switzerland Australia Poland Denmark Portugal Others

August 2009

11

Market Composition:To top export destinations, Indias share in their import portfolio is around 4%
India Share of Top Importing Countries Average: 2001 2005 Indias share of Countrys Imports 60% 56.4% 50.6% 44.2% 40% 20% 51.2% 25%

Countrys Share of Total World Imports 30%

50%

48.8%

36.9%

30%

28.8%

15% 20.6%

20% 12.7% 10% 9.4% 8.5%

15.7%

17.3% 14.9% 11.4% 4.4% 4.6% 9.3% 4.9% 13.2%

10%

5%

0% USA Italy China, 30.9% Share of World Exports India, 2.2% Source : ITC Germany France China Uk Japan Spain Belgium Canada Mexico Austria Korea Romania Australia Denmark Others

0%

Netherlands

Seitzerland

Poland

Portugal

Chinas share of the countrys Imports

Indias share of the countrys Imports

Countrys share of Total World Imports

12

Market Composition Exports from key countries segment-wise (excluding India and China) The export value of the top 10 countries other than India and China in the leather and footwear categories Apparel Italy Malaysia Germany Pakistan Thailand USA France Turkey Belgium UK and Northern Ireland USD (000) 1353586 1255069 669130 618830 597758 595171 529953 380378 363580 341880 Leather Goods France USA Germany Italy Poland Mexico Brazil Austria Hungary Slovenia USD (000) 308419 303204 127378 120362 117047 115146 109678 104551 91010 78860

Footwear Italy Belgium Germany Spain Brazil Romania Netherlands France Portugal Indonesia
Source: ITC, 2005

USD (000) 8859980 2522321 2421873 2189177 1979367 1589037 1525036 1517768 1486971 1428518

Finished Leather Italy Brazil USA South Korea Argentina Germany Spain Thailand Pakistan France

USD (000) 3913849 1394313 1082539 855721 810372 665486 378690 335592 306662 298641

August 2009

13

Segment Composition

Composition of India Exports Average : 2001 - 2006 6.3%

Composition of China Exports Average : 2001 - 2006 2.6% 1.9%

23%

26.1%

42.5% 28% 69.2%

Footwear Leather Source : ITC , Comtrade

Leather Apparel Leather Goods

Footwear Leather Apparel

Leather Leather Goods

Footwear constitutes 62% of world imports. However, Indias footwear exports form less than half (41%) of its total exports. Also, finished leather which has significantly lower value addition compared to footwear constitutes 29% of Indias exports. China exports just 2.8% in the form of Finished Leather and over 68% as footwear

Composition of World Imports Average : 2001 - 2006 16.4% 62.8%

2.9%

17.8%

Leather Leather Goods

Leather Apparel Footwear

14

Sub-Segment Composition Finished Leather SITC Code - 611 India exports nearly 40% of its finished leather to China. Italy and Spain are the other key destinations. USA forms 5.4% of global imports of finished leather but only 1.9% of Indias portfolio.
Finished Leather Average % of Indias Exports : 2001 - 2005 1% 0.9% 1.9% 1.4% 2.1% 2.4% 1.9% 2.8% 1.5% 9.8% 39.8% 1.3% 1.1% 1.1% 1.7% 1.5% 0.9% 1.2% 1.7% 2.3% 6% 2.9% 5.1% 5.2% 15.1% China Italy Germany Korea Viet Nam Spain Malaysia France USA Portugal South Africa Indonesia Thailand Russian Federation Netherlands Others China Italy USA Mexico Romania Germany Spain Poland 2.6% 3.1% 2.3% 2.7% 3.8% 4.0% 4.1% Portugal Thailand India Slovenia UK Vietnam Korea France 4.6% Hungary Japan Turkey Canada Others 5.4% 13.8% Finished Leather Average % of World Imports : 2001 - 2005 14.8%

26.2%

Source : ITC

August 2009

15

Footwear SITC Code - 851 UK, Germany and Italy are the major export markets for Indian footwear. However, one of the largest markets USA (which accounts for 28.1% of global imports of footwear) is not among the top three destinations for Indian footwear exports.
Leather Footwear Average % of Indias Exports : 2001 - 2005 10.9% 1.3% 1.3% 1.2% 1.4% 1.6% 2.3% 2.1% 2.8% 21.1% Leather Footwear Average % of World Imports : 2001 - 2005

28.1% 24.4%

4.5% 17.6%

1.0% 1.0% 1.3% 1.5% 1.9% 2.4% 2.1% 2.7%

12.7%

1.3%

6.5%

7.8%

5.3%
13.0% Portugal Belgium Denmark Austria Canada Australia Others USA China Germany UK France Italy Japan Belgium Source : ITC

6.7% 6.1% 6.5%

Spain Netherlands Canada Austria Switzerland Australia Denmark Others

UK Germany taly United States of America France Spain Netherlands United Arab Emirates Source : ITC

16

Leather Goods SITC Code - 612 USA, Germany and the UK are the major export markets for Indias leather goods and are also leading importers of leather goods in the world. Mexico, the second largest importer of leather goods is not a key destination for Indias leather goods
Leather Goods Average % of Indias Exports : 2001 - 2005 10.2% 18.9% 2.5% 0.6% 1.0% 1.4% 1.6% 1.3% 1.6% 0.6% 1.4% 11.6% 3.2% 1.9% 2.0% 2.3% 1.8% 2.3% 6.3% 15.7% 7.6% 9.2% USA UK Germany France Italy Spain Netherlands China Source : ITC Sweden Australia Belgium Canada Denmark Malaysia United Arab Emirates Others USA Mexico UK Germany Canada France Czech Republic Japan Slovenia China Hungary Spain Belgium Source : ITC 3.1% 4.8% 3.7% 4.2% 4.4% 3.5% 5.7% 6.3% Leather Goods Avg % of World Imports 2001 - 2005 11.0%

1.2% 0.5% 1.9% 1.6% 2.1% 3.4% 2.8%

18.6%

12.5%

4.0%

Poland Italy Singapore United Arab Emirates Netherlands Australia Sweden Switzerland Romania Russian Federation Austria Others

August 2009

17

Leather Apparel SITC Code - 848 Germany, Spain and Italy are the major destinations for Indias leather apparel. USA forms 33.9% of global imports of leather apparel but only 16.9% of Indias portfolio.
Leather Apparel Average % of Indias Exports : 2001 - 2005 11.8% 1.1% 1.4% 1.4% 1.2% 1.3% 1.8% 2.0% 3.0% Leather Apparel Avg % of World Imports 2001 - 2005

16.8%

18.8% 33.9% 1.0% 1.0% 1.1% 1.4% 1.3% 1.6% 1.9% 2.2% 3.0%

7.2%

7.0%

15.3%

2.9% 3.9% 5.3% 7.1% 5.1% 7.3%

16.9% Germany Spain Italy USA France UK Netherlands Denmark Canada Australia Chile Belgium Sweden Portugal Others USA Japan Germany China France UK Italy Spain Canada

1.2%
Belgium Netherlands Switzerland Australia Austria Sweden Denmark Mexico Others

18

Key conclusions for Indian leather and footwear sector Low market share, declining over a period a time Indias share of global exports was only about 2.2% for the period 2001 2005 Indias share declined from 8% in 1980s to current levels. In comparison, Chinas share increased from 0.41% in 1981 to around 35% in 2005 Low share of value-added products Indias footwear exports formed less than half (41%) of its total exports. On the contrary, finished leather which has significantly lower value addition compared to footwear constituted 29% of Indias exports. In comparison, China exported 68.2% as footwear and 2.8% as finished leather. Export portfolio not aligned to key segments India exported about 71% as value added products namely leather footwear, leather apparel and leather goods.

Footwear constituted 62% of world imports. However, Indias footwear exports as mentioned earlier formed less than half (41%) of its total exports. However, finished leather constituted 29% of Indias exports while the share of finished leather in the global imports is only 18%. In comparison, China exported as high as 97.2% as value added products. Geographic portfolio not aligned to key markets One of the largest markets for footwear USA (which accounted for 28.1% of global imports) is not among the top three destinations for Indian footwear exports. Similarly, USA forms 33.9% of global imports of leather apparel but only 16.9% of Indias portfolio. One segment where India is aligned to key customer markets is finished leather which is in the upstream side of the value chain. In comparison, the USA which is the largest importer of leather products is the top destination for China. In summary, China has aligned itself significantly better to the global leather trade compared to India

In summary, China has aligned itself significantly better to the global leather trade compared to India

August 2009

19

India and China evolved as leading footwear producing nations during the same time period (around 1980s). However, over the next two decades, China became the worlds leading producer of leather and footwear products while Indias market share reduced during the same time period

1 2 3

Zone 1 2 3 4 5

Year 1960s 1970s-80s After 1980 After 1990 After 2000

Countries USA, European countries (Germany, France, UK etc) Korea, Taiwan China, India Vietnam, Indonesia, Brazil African Countries (Ethiopia, Kenya etc)

Indias share in world leather trade had been in the declining trend from 8.8% in 1981 to 2.3% in 2005, whereas China has increased its share from 0.41% in 1981 to around 35% in 2005.

20

India and China had exported equal number of pairs of leather footwear during early 80s. However Chinas footwear exports had increased multifold and it is now the worlds largest supplier of leather footwear.
Exports of leather footwear from China and India

The CAGR of Chinas footwear exports during the period was around 13% while Indias CAGR stood at 11%

Pairs (mn) 1400

1200

1000

800

600

Source: FAO , China Leather Industry Associations website, Council for Leather Exports website Chinas export data includes inter-country trade by Hong Kong Report on The status of Vietnam leather goods and footwear Industry in 2006 and six months of 2007 Dr. Nguyen Thi Tong

400

200

1986-88 1989-91 1992 China India

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2007

Based on the above, studying the growth pattern of leather industry in China would enable us understand the key factors that led to growth and the initiatives at various levels that would enable competitiveness of the sector and firms in the sector.

In the region, Vietnam is an emerging center in the global leather and footwear trade that could have been considered for comparison. However, Vietnam could not fit into the comparative analysis due to the following reasons while China was best placed. Vietnam, unlike India and China is focused significantly on the footwear segment ( about 78% of their capacity is for manufacturing footwear). Even, in the footwear category, Vietnams focus is on sports shoes ( 70% of the total footwear produced). Global market share is around 1.4% as compared to 2.3% for India and 31% of China. Hence identification of the critical success factors for growth would be more relevant for India when compared with China than with Vietnam Incidentally, 50% of the Vietnamese leather firms are foreign owned (similar to China)

August 2009

21

Tracing the evolution of leather industry in India and China

Evolution of Chinas Leather Sector (Wenzhou Cluster) The growth of the leather industry in China is attributed to the first wave of economic reforms in 1978 with rapid development of Town and Village Owned Enterprises (TVEs) and second wave with foreign firms investing in China. In 2000, nearly 24% of the leather firms were foreign owned accounting for 57% of total sales. Till 1900s Traditional Business: Shoe making has a history of more than 500years in Wenzhou. During the Ming Dynasty (1368-1644), Wenzhou footwear was known for its exquisite quality and was produced exclusively for the Royal Family 1900 1950s Initial Industrialization: During 1910s, footwear industry in Wenzhou flourished with shoe makers learning advanced techniques and setting up many factories. In the early 1950s, the Government had taken over almost all the shoe factories and the remaining factories were closed 1950 - 1978 Pre-Economic Reforms: Private shoe manufacturing was largely depressed in this time. State Owned Enterprises (SOE) also did not perform well and in the year 1978, only 19 factories were operational producing around 0.5 mn pairs a year. 1978 till now Economic reforms and open door policy: First Wave - 1978-1991: Rapid development of Town and Village Owned Enterprises. Second Wave since 1991 : Rapid development of Foreign Invested Enterprises & Private Owned Enterprises. 80% of the foreign invested firms were Taiwanese in the 1990s. Incentives provided by the Government: 2 year tax exemption, 50% income tax on the third year, single-window clearance for all approvals and delegation to local authorities for approving foreign investments.
Sources: The Role of Clustering in Rural Industrialization: A Case Study of the Footwear Industry in Wenzhou : May 2007, New Competition: Foreign Direct Investment and Industrial Development in China: 2004 CLE Country Study China Trade liberalization and environmental protection - A Study of Leather Industry in Brazil, China and India

22

After the economic reforms, the leather industry saw more conducive environment for growth with the rise in TVEs and FIEs Leather Industry Development of TVEs: As more and more SOEs were closed, footwear products were in short supply. This strong market demand prompted the rapid development of TVEs. Division of Labour: TVEs specialized in producing single / few processes / sub-components for the footwear industry which brought down the technical barriers to entry Access to Capital: Most of the credit was through own funds and funds from friends / relatives. Trade credits were also common. Governments policy to support FIEs: Incentives were provided for FIEs ranging from tax holidays for 2 years, 50% on tax in the third year, single window clearances and power for the local governments to promote FIEs Rise of FIEs: In the second wave of the economic reforms, FIE investment flowed in predominantly from Hong Kong and Taiwan. Access to markets: FIEs brought in the access to markets. Taiwanese investment comprised 80% of the total foreign investment in the leather sector in China which was instrumental in accessing the US market.

1978 - 1991 Economic Reform Phase 1: The basic institutional framework of central planning remained largely intact. Meanwhile new competitive forces were injected into the economy through transitional institutions. Competitive product markets were created by curtailing central planning and moving towards market-based prices.

1992 till now Phase 2: Major reforms included the unification of exchange rates, current account convertibility, the reform of tax and fiscal systems, the reorganization of financial regulatory system, the adoption of Western accounting rules

Moving towards Market economy: The Central economic agents were slowly reorganized to improve their Dual Track Reform: The dual-track price reform was based competitiveness. SOEs were organizationally restructured into upon the logic of continual enforcement of the central limited liability corporations according to the newly passed planning while simultaneously liberalizing the markets. Company Law. They were required to induct Directors to Under this, central economic agents were assigned rights to form boards, to hold shareholder meetings and to establish and obligations for fixed quantities of goods at fixed planned boards of supervisors. prices as specified in the pre-existing plan. Meanwhile, a market track was introduced under which economic agents participated in the market with free market prices, provided that they fulfill their obligation under the plan.

Sources: Foreign Direct Investment and Industrial Development in China, 2004 Ownership biases and FDI in China, Yasheng Huang 2008

August 2009

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Rise of TVEs and FIEs, Cluster based approach and the governments incentives were the key reasons for the growth of leather industry in China Rise of Town and Village Owned Enterprises (TVEs) in the first wave (1978-1991) and the penetration of Foreign Invested Enterprises (FIEs) in the second wave (from 1991) Most of the investments from Hong Kong and Taiwan. Cluster based approach brought down the entry barriers and improved the operational efficiency High level of division of labor. Incentives provided by the Government for the Foreign Invested Enterprises (FIEs)

Incentives ranging from subsidized land, power, reduction of import duties, tax holidays etc. Overall improvement in the infrastructure which enhanced the competitiveness of the industry. The favorable factor conditions present in China was utilized well by the FIEs who enabled China to become a leading exporter by providing easy access to its customers. The Indian leather industry had evolved from being a semi-finished leather exporter in the 1960s to exporter of high quality leather footwear and products today. While there is significant potential for growth, Indian leather exports achieved a moderate growth rate of around 7% in the last 10 years.

1850s 1930s Cottage Industry: British government aimed at procuring cheap semifinished leather and exporting it to Europe for processing

1930s 1940s Mechanization of the factories: Mass production with professional labour primarily vegetable tanning otherwise known as East India tanning

1950s- 1980s Mechanization gained momentum: During this time, mechanization rapidly increased. Chrome tanning was introduced and there was increasing demand for finished leather in the foreign markets. Tanners setup their own footwear upper manufacturing units Government Focus: Employment generation, Earning foreign exchange through Reservation and Restriction on semi-finished leather Small Scale reservation: Incentives and licensing policies aimed at promoting leather and footwear industry in Small and Medium sector Focus on Value addition in leather industry: Government restricted the export of semi-finished leather by imposing export tax

1980s till now Ban on the export of semi-finished leather & Focus on Leather Products: Import duties on all tannery, finishing, footwear, and other leather goods machinery were lowered to a uniform rate of 25%. Outsourcing: Increasingly large footwear companies outsourced their labour-intensive less-critical operations to SSI sector De-reservation of Leather & Leather Products in 2001: To enable economies of scale to compete in the global market However, Less developed component industry affects the growth of the leather sector

Source: Trade Liberalization and the Restructuring of Tamil Nadus Leather Sector: Coping with Liberalizations New Environmental Challenges and Lessons from Prior Episodes of Adjustment - Meenu Tewari Competitiveness through export clustering: Strategic considerations- UNIDO - 2005

24

Indian leather industry is moving up the value chain with leather products constituting more than 75% of the exports Indian government banned the export of semi-finished leather in 1991 in order to stimulate the value addition in the leather sector In 2007-08, the share of finished leather was around 22% and the remaining share is from value added products

100%

80%

60%

40%

20% Semi finished leather 0%

1975-76

1977-78

1979-80

1981-82

1983-84

1985-86

1987-88

1989-90

1991-92

1993-94

1995-96 1997-98

2007-08

Leather products

Finished leather

Semi finished leather

While Indian leather exports grew at a rate of 8.8% (despite a low market share) during the period 2001-2005, China grew at more than 12% over the same time. Indias stagnant market share in world exports can be attributed to sub-optimal scales, low level of FDI and lack of supporting industries Majority of the Indian firms are proprietorship / partnership / privately owned companies Lack of scale economies due to investment constraints Lack of awareness on latest management techniques and decision making abilities Low levels of FDI in the leather sector; Only Rs 200 Crores from 1991 to 2005 Foreign firms, who were instrumental in boosting Chinas exports to world markets were absent in India.

Indian leather sector was devoid of FDI which typically brings in state-ofthe art machinery, best practices in the industry and efficiencies in operations / management that would positively influence the competitiveness of the sector. The footwear accessories industry is less developed ( most of the companies possess small capacities) leading to supply constraints and sub-optimal scales. India is dependant on China for most of the accessories. Indian firms were naturally aligned to European markets, given its requirement for low-volume, high-variety products. Indian firms were not typically preferable for the high-volume US market which is worlds largest consumer

August 2009

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Analysis of the Indian leather industry and key conclusions

Porters Diamond Framework has been employed to compare the competitiveness of Chinese and Indian leather industry Structure of the industry Foreign Direct Investment Collaborative / cluster based approach among firms Firm Structure & Rivalry

Government

Economic reforms Incentives for firms Attracting foreign investments

Factor Conditions

Demand Conditions

Labor cost Infrastructure related costs Access to Capital Raw material availability Support Industries Access to Foreign markets Local demand

Upstream and downstream Industries Associations and Institutions

26

Factor Conditions

Labor cost Infrastructure Access to capital Raw material availability

August 2009

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Labor cost Developing countries in Asia took advantage of the shift in the leather and footwear manufacturing, predominantly due to the lower labour costs. Indias labour cost is about 3% of Italys labour cost and Chinas labour costs are around 7% of Italys labour cost The slow technical development in footwear operations, particularly in the production of uppers make footwear manufacturing a labour intensive operation as a result of which companies are forced to move to /access countries and regions with lower wages. This is the primary reason for the shift in the geographies of leather production in the 80s. While in Italy labour costs accounts for 38% of the production costs, it is less than 10% in developing countries
Worker Cost in 2008 (USD/Hr)

USD
30 25.24 25

20 15.13 15

10 6.93 5 0.43 India 0.48 Vietnam 0.75 Indonesia 1.08 1.1 1.15 4.16 2.59

Thailand

China

Pilippines

Mexico

Brazil

Korea

Italy

Japan

Source : The global leather value chain Presented to UNIDO, Feb 28, 2001 Leathers July 08 edition CLE, World Bank report - 2004

28

In the key segment of footwear, the labour cost per item in India is cheaper by 41% over China although the productivity of Chinese employees is higher by 33% (in leather garments/apparel India and China have the same effective cost). Also, Chinas labor policies are perceived as more employer friendly than Indias labor policies.

Product

Daily Production (Pairs / Nos) India China 6 15 5 10 15

Monthly Production (pairs/Nos) India 120 360 60 240 360 China 180 450 150 300 450

Monthly Wages (USD) India 103 103 103 103 103 China 264 264 264 264 264

Labour cost per item (USD) India 0.86 0.29 1.72 0.43 0.29 China 1.47 0.59 1.76 0.88 0.59

Shoes (Men) Shoes (Women) Garments (Jackets) Bags (Women) Wallets

4 12 2 8 12

Country India China Bangladesh Srilanka Pakistan Korea Singapore Malaysia Thailand

Hiring and Firing Practices 2.6

Factor Condition

Importance

China

India

Labor Cost 4.5 4 2.7 4.5 4.1 5.9 4 4.2

Source: Leathers July 2008 magazine from CLE, Exim bank report 2006, The Indian Footwear & Leather Industry CII, Global Competitiveness Report 2005-06, Global Competitiveness Report World bank 2005-06

1 Impeded by Regulations 7 Flexibility determined by employers

August 2009

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Rising labor costs in China forces the migration of the leather companies towards the central and western region
Risng Labour Costs in Chinese leather Industry USD 1.5 1.3 1.1 0.9 0.7 0.5 0.3 0.1 -0.1 2003 2004 2005 2006 2007 2008 0.39 0.44 0.51 0.7 0.6 1.1

While India has an advantage on unit costs today, Indian leather companies are facing severe attrition and there is a shortage of skilled and semi-skilled labour Operation Primary Collection Tanning (Organized) Footwear (Cottage& Household) Footwear (Organized) Other leather Products (Organized) No of employees (mn) 1 0.1 0.9 0.2 0.3

Most of the Chinese leather companies are situated in the east coast of China and labour costs are increasing in the east coast due to high economic activity. Labour cost in leather industry increased from 0.39$/hr in 2003 to 1.1$/hr in 2008 The higher labour costs are driven by the new Labour Contract Law ( LCL) which mandates transparent employment terms and empowers workers to bring legal action against employers who do not pay proper wages, insurance etc. Due to these reasons, Chinese companies are forced to relocate their factories to interior provinces of China where labour costs are relatively low. Companies in the coastal regions would focus on high value products and the companies moving into the central and the western region on low value products
Source: The global leather value chain Presented to UNIDO, Feb 28, 2001, Leathers July 08 edition CLE, World Bank report - 2004

Leather and Footwear industry was encouraged by the government as a means to increase employment generation. The sector was under SSI reservation till 2001. Total employment in this sector would amount to 2.5 million (30% of which are women) Footwear industry provides employment to the uneducated population - 40% of employment is represented by unskilled workers doing table work operation in the assembly line In the last few years there is a severe attrition in the companies (with the rate around 15%) There is a lack of skilled & semi-skilled labor causing the increase in attrition The setting up of SEZs of other industries near the leather production clusters has also led to increase in attrition. For e.g. In Tamil Nadu, companies which produces electronics parts and products in Sriperumpudur attract labor from the nearby leather cluster (Ranipet). These electronics companies provide attractive salaries, transportation facilities and good working conditions which attracts labor from leather industry Key issue for China: Increasing labour costs Key issue for India: Shortage of skilled labour

30

Infrastructure Indias infrastructure acts as a significant deterrent to its competitiveness compared to competing countries like China Country France Japan Canada India China Logistics cost (cents per Km) 5.5 3.7 2.0 7.0 5.0

The average clearance time in the ports is nearly 3.47 days in India compared to 16 hours in China Country India China USA Indonesia Taiwan Korea Documents for Export 10 6 6 7 8 5 Time for Export (Days) 22 7 5 3 9 3 Documents for import 36 20 9 25 14 12 Time for import (Days) 15 11 5 10 8 8

According to the World Bank Logistics Report 2007, that rated India 39th among 150 nations, some of the reasons for high costs of logistics in India Quality of Infrastructure Competence of private and public logistics service providers Higher clearance time in entry locations like ports and other border agencies Reliability of the trading system and the supply chain Corroborating the above, Indian logistics is characterized by higher levels of inventory and therefore warehousing costs driven by low speeds on highways (average 30 Km per hr as against 60 km per hr in Europe) Power outages are very frequent in India, while there is an outage only once in two weeks in China. Indian companies are losing about 8.4% a year on the sales compared to less than 2% in China Share of firms owning Generators (by Size) Country China India Micro 0% 23% Small / Medium 14% 76% Large / Very Large 38% 91%

Time for exports/imports refers to the time the business starts preparing the necessary documents to export/imports goods until the time the cargo is in the warehouse.

Chinas infrastructure is ranked higher than Indias infrastructure in all the sub-sectors (Electricity, Water, Roads and Ports) which helps in its development of trade Country China India
1- Worst 7 - Best

Electricity 4.6 2.7

Water 4.9 4.6

Roads 4.6 3.3

Ports 3.8 3

Factor Condition

Importance

China

India

Infrastructure

Sources: Current status of logistics in India- G. Vaidyanathan, CII Institute of Logistics, Infrastructure Challenges in East and South Asia March 2006, Emerging Markets Infrastructure: Just Getting Started-Morgan Stanley April 2008, Business Environment and Comparative Advantage in Africa: Evidence from the Investment Climate Data, 2005, The impact of business environment and economic geography on plant level productivity: An analysis of Indian industry, The World Bank-June 2005. Trade logistics in the Global Economy - The world bank Logistics report 2007

Sources: The impact of business environment and economic geography on plant level productivity: an analysis of Indian industry, Development Research Group-The World Bank-June 2005, Infrastructure Challenges in East and South Asia March 2006, Emerging Markets Infrastructure: Just Getting Started-Morgan Stanley April 2008

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Infrastructure: Primary Survey Nearly 70% of the respondents believe that customs clearance, inland transportation delays and power outages are the key disablers of their competitiveness
% of companies who responded that infrastructure has significant impact 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% .% Customs Clearance delays Inland Transport delays Power Outages / Cost of own power Water Others

Multiple responses allowed Source: Primary Survey conducted by Deloitte

32

Access to Capital In China, Capital was denied to private firms during 1980s. Most of the startup companies used their own funds. During the emergence of FIEs most of them sold their stake to foreign investors A large number of leather companies which were started during the 1980s used own funds or capital borrowed from friends / relatives
Sources of Capital - 1980s 8.35%

The outcome of this allocative pattern is that private entrepreneurs accessed capital by selling their equity shares to companies based in Hong Kong and Taiwan. However, post 1997 Chinese banks have been providing finance to private firms after the credit quotas have been removed by the government. Indian SMEs in the leather sector have very low access to the bank funds though leather has been a priority sector for lending. Many of the small and medium businesses in India do not access bank capital. Only 16% of the loans find the way to the SME sector and since more than 75% of Indian companies are in the SME sector, their access to bank funds is low. Most of the investment requirements of the leather sector is funded through internal sources or community funding, which remain the preferred sources of financing. Poor maintenance of the books of accounts has made it difficult to access bank loans which require clear and transparent accounting practices. Factor Condition
Access to capital

0.30% 24.50%

66.00%

Own Funds Relatives & friends

Banks Public Funds and Others

Another common practice was the use of trade credits from upstream and downstream enterprises to ease working capital constraints. Members of the footwear clusters are located in close proximity to one another, leading to repeated business transactions and the formation of a certain level of trust among the upstream and downstream firms in the production chain. In industries such as garments and shoe-making, Chinese private firms ought to have possessed strong competitive advantages, but poor allocative decisions of Chinese financial institutions imply that a severe mismatch between human and financial capital existsi.e., efficient private firms were denied financing, whereas inefficient SOEs are favored.

Importance

China

India

Source: The Role of Clustering in Rural Industrialization: A Case Study of the Footwear Industry in Wenzhou : May 2007, The role of Foreign-Invested Enterprises in The Chinese economy: an Institutional Foundation approach - Yasheng Huang

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Raw Material Availability Chinas high production of leather is not reflected in the quality of domestic hides and skins due to poor slaughtering practices and inferior quality of cattle
Production of Bovine Hides and Skins - Countrywise - 2004 0.14% 0.40% 0.36% 0.13% 0.1% 0.01% 0.01% 0.01% 0.01% 0.02% 0.03% 0.06% Production of Skins of Sheeps & Lambs - countrywise - 2004 0.17% 0.22% 0.3% Production of Skins of Goats and Kids - countrywise - 2004

0.08% 0.12% 0.02% 0.02% 0.02% 0.03% 0.04% 0.04% USA China Brazil India Argentina Russia 0.02% 0.02% 0.05% 0.02% 0.04% 0.04% China New Zealand Australia UK India Spain Iran South Africa Algeria Turkey Others 0.05%

0.07%

0.07%

0.27%

Australia Mexico France Italy Others

China New Zealand Australia UK India Spain

Iran South Africa Algeria Turkey Others

Though China is the leading producer of hides and skins, the quality of Chinese leather is considered to be of inferior quality. For E.g. Nearly 70% of pig skin produced by China are inferior in quality*. The quality of the skin is inferior because of: Damages in the hides because of injuries, whip marks and gadflies. Hides are not strong or thick because the cattle is mostly old and sick when slaughtered Some slaughter houses damage the skins unintentionally due to their low technology.

The quality of domestic leather production is inconsistent and varies among different production centers. India: Pig farming in India is in nascent stage. Pigs constitute only 2.78% of our live stock (around 13.5 million).As majority of Indians dont prefer pig meat (pork), the consumption of pork is only 7% of the total meat consumption. Therefore, CLRI is now developing leather from low grade cattle skins that can compete with the Chinese pig skin leather.

Source: FAO, EXIM Bank report, * - CLE Country study of China http://economictimes.indiatimes.com/News/News-By-Industry/ET-Cetera/India-should-look-at-improving-pig-raising-practices/articleshow/4480325.cms http://www.thehindubusinessline.com/2004/07/13/stories/2004071301630300.htm

34

Due to the poor quality of the domestic hides, China imports large quantity of leather and the trend is increasing over the years.
Production and Import of light bovine leather - China 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 1986-88 1989-91 1992 1993 1994 1995 1996 1997 1998 1999 2000 2201 2002 2003

mn Sq ft

Trade with Hong Kong, Macau and Taiwan considered in the above data Production

Availability of livestock (raw materials) has a moderate impact on the leather industry. China produces lesser sq ft of cow skins compared to India. However, there are no shortages as the shortfall is met through imports

Countries like China, Vietnam, Thailand etc are importing leather in finished / semi-finished form to manufacture leather footwear / products. In China, nearly 80% of the leather used for manufacturing is imported from various countries

Import Value of leather by the countries (000 USD) 2001 China Vietnam Thailand
Source: ITC, FAO 2005

2002 3,587,837 361,559 234,224

2003 4,085,898 492,607 306,364

2004 4,725,088 NA 302,551

2005 4,841,649 NA 333,219

3,634,806 224,909 214,493

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India is rich in the availability of cattle and has the highest share of bovine animals in the world. But the production of hides from bovine animals is low due to the ban on cow-slaughtering in a majority of Indian states
Country- wise share of Bovine Animals -2005 Production of Bovine Hides and Skins -Country-wise -2004

India Brazil China USA Argentina Pakistan

Ethiopia Sudan Mexico Australia Others

USA China Brazil India Argentina Russia

Australia Mexico France Italy Others

The slaughtering of cows is banned in most Indian states. The animal is considered sacred by India's majority community and beef is not consumed by most of the people in India However, Cow slaughtering continues to be carried out in unlicensed abattoirs. According to Dept of Animal Husbandry, there are approximately 25776 unlicensed abattoirs in operation in India today against 5521 legal abattoirs. This also affects the quality of hides which is low on account of improper slaughtering practices. Given the above, corporate / organized players would find it infeasible/difficult to deal / operate in this segment

Source of raw hides Raw hide from slaughtered animals Raw hide from fallen animals Imports

% in total consumption 60% 30% 10%

Factor Condition
Raw Material Availability

Importance

China

India

Source: Compiled from FAO, EXIM Bank report, PETA- The Hindu, Sep 12, 2003, Dept of Animal Husbandry

36

Demand Conditions

Access to market

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Domestic demand Indian footwear industry Indias footwear industry is valued at around $ 5 bn and nearly 1.8 bn pairs. The domestic market is highly competitive with few national players and multinational players present in the organized segment and a large unorganized segment characterized by chappals / sandals served by small scale players The growth rate of the Indian domestic footwear industry is around 8 % and is predicted to grow at around 7.5~8% in the near future.

Indian Footwear Industry - Value 10 9 8 7 (in bn USD) 11.0% % growth 6 5 4 3 2 1 0 2003 2004 2005 2006 2007 2008E Year 2009E 2010E 2011E 2012E 5.0% 7.0% 9.0% 13.0% 15.0%

Indias current market size is around $5bn Population 1.1bn Per capita consumption 1.6 pairs / yr Average value of a footwear = ( $ 5 bn)/( 1.1bn * 1.6) $ 2.84 per pair of footwear Rs. 128 per pair ( 1 USD = Rs 45)
Source: Council of Leather exports, Datamonitor (Export of leather uppers not included )

38

Domestic market for footwear is promising with large corporate entering the organized retail business. Per capita consumption of footwear in India is very low compared to other economies. However, the demand for footwear is rising with organized retail gaining more market share. Modern format Footwear retail is one of the most organised retail format in India and has 48% share in the total sales. Increasingly major players like Tata, Khadims, Reliance etc., are entering the retail business. Majority of the Indian footwear sales is the casual footwear followed by economy shoes. Premium leather shoes has a share of around 7%

Country USA Japan European Union Brazil Thailand China India*

Consumption (mn pairs) 1939.7 584.4 1666.5 483 144.4 2768.7 1800

Population (mn) 290.3 127.2 380.2 182 64.3 1286.9 1100

Per-capita pairs per person/year 6.68 4.6 4.38 2.68 2.25 1.71 1.6

Segments Watches Footwear Health & Beauty Services Consumer Durables Mobile Handsets & Accessories Books, Music & Gifts

% Organised formats 2004 39.60% 25.00% 6.00% 7.80% 6.50% 9.80% 2005 43.50% 30.30% 7.60% 8.80% 7.00% 11.70% 2006 45.60% 37.80% 10.60% 10.40% 8.00% 12.60% 2007 48.90% 48.40% 14.30% 12.30% 9.90% 13.40%

Mens footwear accounts for almost 50% of the market. Around 40% of the market is womens footwear and the remaining 10% by Childrens footwear. Footwear has different segments like sports footwear, semi-formal/casual footwear, and formalwear and utility footwear.

% Sales of footwear segments

Casual Economy Premium Non Leather Premium Leather Sports / Active

Source: Deloitte Estimates

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Access to market China: The Foreign Invested Enterprises (FIEs) of China were predominantly from Hong Kong and Taiwan. FIEs control of access to the Western markets led to its dominance in exports from China. The FIEs brought in the linkages with the western markets. FIEs exported 99.9% of their production whereas domestic firms exported 34.8% of their production in 1997. In a number of labor-intensive industries, the FIE shares of industry sales seem to be substantial as well. In 1995, FIEs accounted for 30.7 percent of sales in furniture manufacturing, 50.8 percent in garments, and 54.1 percent in leather and related products. Hong Kong imported and exported nearly 1.4 bn pairs of footwear from China in the year 1996 demonstrating that the FIEs from Hong Kong and Taiwan acted as a bridge between mainland China and the western world Large scale investments by FIEs enabled Chinese manufacturers to cater to the high volume US market Factor Condition
Access to Market

India: Indian companies were traditionally aligned to European market whereas the largest market was left untapped by Indian companies. Domestic market is also growing due to the rising income levels and low penetration of leather footwear. European buyers of finished leather from Indian suppliers, played a major role in diversification into leather products The main reason is their local production base in Europe had shut down or moved abroad. Small order quantities and more focus on design enabled Indian leather industry to take advantage of the European footwear industry Access to Technology: Chinese companies have access to technology owing to the foreign investments which also brought in the necessary technology. However, in India as most firms are small and medium sized family owned businesses, access to technology is relatively very low. A case to point is the chemical consumption in Indian tanneries which is about 25 to 30% higher than international norms primarily due to the use of inefficient equipment and processes and the absence of recycling . The specific consumption of water in Indian tanneries is more than double of that in tanneries in the developed countries. The tanning units in India consume at an average 40 ltr/sq ft of finished leather as against 12-15 ltr/sq ft in the tanneries in developed countries While institutes like CLRI and FDDI play an active role in developing and dissipating technology to the industry, the firm structure has an important bearing on the adoption of technology.

Importance

China

India

Source: FDI and the Opening Up of Chinas Economy, Franoise Lemoine, 2000 Indian Footwear Industry, 2002 CII, Barriers and Opportunities for Promoting Trade in Environmentally Friendly Products- A Study of Indias Leather Industry - 2002

40

Firm Structure and Rivalry

Increasing number of FIEs/TVEs Cluster based approach

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41

Increasing number of FIEs / TVEs Evolution of TVEs and FIEs in the leather industry increased the market share of China in the world leather trade from less than 3% in 1980 to more than 20% in 1997 Phase 1: 1978 to 1991: During this phase a large number of Collectively Owned Enterprises (COEs) / Town and Village Owned Enterprises (TVEs) were formed which operated in an optimal income sharing model important feature of TVEs were the community (town or village) control of firms TVEs could overcome the obstacles of access to capital through help from local (community) governments since there was a strong lending discrimination against POEs Phase 2: 1992 to till now: The number of foreign owned enterprises increased significantly and in 1997 more than 53% of the output of leather were from FIEs

The foreign ventures use imported machinery and chemicals with guaranteed standards. More important, these enterprises helped improve quality standards during the tanning process. In addition, they were willing to invest in technology improvement and staff training. The results of their efforts were usually reflected in better quality of their products and in the export share of their products (more than 99%) FIEs accounted for nearly 57% of the total exports from China in 2000
Shares of Ownership in Total Industrial Output 80 70 60 50 40 30 20 10 0 1980 SOEs 1985 1990 COEs 1991 1992 1993 1994 POEs FIEs 1995 1996 1997 1998 1999

Joint Stock Companies

Ownership pattern in Chinese Leather companies 100 90 80 70 60 50 40 30 20 10 0 1995 State Owned Enterprises Others 42 1997 12 10 2007 Collectively Invested Foreign Investments 7 68 63 62 3 17 10 17 7 24

Share of Sales in Chinese Leather Industry 100 3 5 37 34 51 50 Source: CLE Country Study China; Foreign Direct Investment and Industrial Development in China, 2004; FDI and the Opening Up of Chinas Economy, Franoise Lemoine 52 31 5 57

12 0 1995 1997

6 2007

Most of the organizations in this sector are proprietorships or partnerships traditionally owned by family members. Lack of investments has led to sub-optimality in size rendering them uncompetitive when faced with cost competition. Limited exposure to best practices in operations / management also hampers their growth. At the firm level, the Indian leather industry is highly fragmented. As of 2002, on a total of nearly 56,000 units, only 2% of the companies have revenues of more than Rs. 50 Crores. Most of the companies are in Rs. 1-10 crore segment China has 200 factories producing 20000 pairs a day (5 mn pairs annually) in a locality, India has only 3 factories of that scale. Nearly 60% of the companies in India are either proprietorships or partnership firms. Lack of scale economies Unwillingness to expand through the debt route** and limited exposure to the capital market has resulted in the companies relying primarily on internal funds for expansion opportunities Consequently, the industry has not witnessed significant capacity additions over the last decade Lack of awareness on best practices** Most of the CEOs of leather companies lack the knowledge of latest management techniques and the best practices of other industries

Structure of India Leather Sector India 5% 2%

18%

1 - 10 (Rs. Crores) 10-25 (Rs. Crores), 25-20 (Rs. Crores), More than 50 Crores 75%

Ownership pattern in Indian Leather sector 2%

28% 39%

Proprietorship Partnership Private Limited Public Limited

Factor Condition
Management Structure

Importance

China

India
31%

Source: DnB Indian Leather Sector, CLE Country Study-China, LEATHERS July 2008, CLE, CII **Interviews with Sectoral Experts

Source: DnB Indian Leather Sector, CLE Country Study-China, LEATHERS July 2008, CLE, CII **Interviews with Sectoral Experts

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Recent trends Firm Structures: JVs and FDI A Chennai based leading leather manufacturer and exporter, specializing in finished leather, shoe uppers and full shoes, has struck a first-of-its-kind joint venture with Conceria Virginia Italy(CVI), a 10-year-old Italian tannery, specializing in leathers for shoes and leather goods, for the setting up of a six million sq. ft per annum state of- the-art leather manufacturing facility in Chennai to produce superior quality of bovine leather in India and cater to Indian market One of the worlds largest Fashion accessories manufacturer LVMH ( Moet Hennessey Louis Vuitton) had acquired 20% stake in Hidesign ( Indian leather goods manufacturer) Entrepreneurs from Taiwan are setting up plants in Andhra Pradesh and Tamil Nadu for producing sports shoes Global Sourcing A MoU was signed between the Ethiopian Leather Industries Association (ELISA) and the Confederation of Indian Industries (CII) which makes it easier to source leather from Ethiopia. The Ethiopian leather industry has been manufacturing mainly wet blue leather for the last 10 to 15 years. It is a typical feature of developing countries, as wet blue is the first stage of the leather value chain. Indian companies would help Ethiopia boost its leather exports and in turn Indian leather products made out of Ethiopian leather would find greater acceptability in global market because of its high quality Fair Labour practices : Compliance to standards like SA8000 is a growing trend among the leather companies with around 20 companies already accredited with the certification However, most buyers (brand owners and intermediaries) have their own standards similar to SA8000 and they conduct periodic audits to confirm whether their suppliers are confirming to the same

44

Cluster Based Approach Most investments in the leather industry in China happened in a few provinces. Operating in a cluster based approach and adopting a collaborative approach for marketing has allowed Chinese companies to deliver large volumes of footwear per order The leather industry in China is clustered in five major provinces Zhejiang, Fujian, Guangdong, Sichuan and Chongqing The production is concentrated in cities like: Wenzhou: More than 4000 companies & more than 400000 employees Haining : More than 2000 companies present in the city. Leather city complex with 160000 sqm and online trade platform. Shiling: Leather complex with 2.5 mn sqm area with more than 900 traders of leather and material, 1200 traders for leather products and 300 offices of companies The products are bought from and sold to the traders in the local market Clustering has simplified the complex production processes into small steps and lowered technical and capital barriers to entry The division of labor decomposes complicated footwear products into numerous intermediate products which enabled many entrepreneurs without shoe making background to participate E.g. sole of footwear is broken down to outsole, mid-sole, insole, heel, sock lining, heel pad etc. Some companies focus on single operation like component assembly, etc

Footwear Production zone in China

Chongqing

Sichuan

Guangdong Fujian

Zhejiang

Source: The Role of Clustering in Rural Industrialization: A Case Study of the Footwear Industry in Wenzhou : May 2007, Chinese Leather Industries Associations website, CLE Country Study - China

Chinese leather industrys strength lies in these clusters where they process millions of pairs of footwear in a cost-effective manner Collaborative approach to Marketing When a bulk order is received, there is a distribution of orders among the eligible manufacturers / suppliers thereby meeting the commitment for exports. Shared infrastructure and lower costs The close geographical location of similar manufacturers within a cluster enables flexibility and capacity pooling to better handle uncertain demand For example, companies can outsource orders or parts of orders that they may not be able to handle themselves to other firms with similar production capabilities within the same geographical area Such an arrangement creates a perception to a purchaser that its entire order is being fulfilled by the same producer.

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45

 The close proximity of similar facilities also allows these companies to share the investment costs of building facilities and other required infrastructure E.g. Common Effluent Treatment Plants (CETPs). Within the supply cluster, shipping costs between suppliers and manufacturers are greatly reduced because of the close proximity of these firms. With frequent small shipments occurring between facilities, in-transit inventorieswhich tie up working capitalare minimized. Though internet is used in few business transactions, information is still being transferred through face-toface interactions. The geographic proximity of firms in supply clusters provides favorable conditions for this kind of information transfer, which results in creating personal relationships (Guanxi in Chinese) and strengthening community ties.
Source: Supply Chain Clusters: A Key to China's Cost Advantage, Lifang Wu, Xiaohang Yue, and Thaddeus Sim - Supply Chain Management Review, 3/1/2006

Footwear Production zones in India

Agra

Kanpur

Kolkata

Unlike China, the collaboration and division of labor among the companies is absent in India. Companies in India, are particular about their buyers information and rarely share them amongst themselves. Though the tanneries and leather footwear production are concentrated in three major locations, there is no visible coordination among the players as compared to their Chinese counterparts This has resulted in supply chain imbalances, high inventory and wastage across the supply chain, making it more disadvantageous for Indian firms to compete in the marketplace. Leather industry is present in these geographies for many years Chennai cluster exported leather for the past 100 years Kanpur is well known for its saddlery products whose history traces back to the military cantonments of British era Factor Condition
Cluster based approach

Ranipet, Ambur, Vaniambadi

Chennai

Source: IBEF 2006, Anecdotal references

Importance

China

India

Unlike China, the collaboration and division of labor among the companies is absent in India. Companies in India, are particular about their buyers information and rarely share them amongst themselves.

46

Primary Survey Less than 50% of the organizations surveyed collaborate with the customers on tactical areas like demand planning, transportation planning and production planning initiatives. Organizations who collaborate with customers have reported benefits Customer collaboration and benefits achieved
% of companies with medium to high collaboration 100.% 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement

Benefits Gained 5 4.5 4 3.5 3 2.5 2 1.5 1 Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement

Indian Leather and Footwear sector

Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit

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47

Similarly, only about 50% of the companies surveyed have engaged in a collaboration with suppliers. However, they have not achieved significant benefits. These levels of collaboration have resulted in delayed deliveries from suppliers. Less than 20% of the companies reported on-time deliveries of over 70% from suppliers Supplier collaboration and benefits achieved
% of companies with medium to high collaboration 100.% 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement

Benefits Gained 5 4.5 4 3.5 3 2.5 2 1.5 1 Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement

Number of on-time deliveries/total number of deliveries (in %)

Industry Supplier Delivery % 60.% 50.% % of companies 40.% 30.% 20.% 10.% .% <50% 50-60% 60-70% 70-80% >80% Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit Indian Leather and Footwear sector

% of On time deliveries 48

Lack of collaboration with the suppliers and customers has resulted in poor visibility along the supply chain Information availability to understand supply chain performance
5 4.5 4 3.5 3 2.5 2 1.5 1 Delivery dates Supplier inventory Supplier capacity FG Inventory Production schedule Capacity Product cost Product profit Customer forecast Customer inventory Customer profitability Customer Service Customer retention

Indian Leather and Footwear sector

Scale 1 = no information available

3 = some information available

5 = information is readily available

Due to poor visibility in the value chain (customer and supplier), Indian leather companies are fraught with inefficiencies in terms of higher inventory and delayed deliveries. Given the nature of the industry and export destinations, these typically result in high levels of obsolescence On- time delivery for most of Indian companies is less than 70%
Industry On Time Delivery 60.% 50.% 40.% 30.% 20.% 10.% .% <70% 70-80% 80-90% >90%

Over 50% of the Indian companies hold 3 6 months stock on an average

Inventory Turns
60.%

50.%

% of companies

% of companies

40.%

30.%

20.%

10.%

.%

<2

2-4

4-6

6-8

>8

% of On time deliveries Percentage of shipments that meet customer request date (for the different peer groups Indian Leather and Footwear sector

Inventory turns (Annual cost of goods sold) / (average total on hand inventory)

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Indian companies are not flexible to meet the dynamic nature of the business like changing product mix, volume etc owing to low levels of collaboration along the supply chain Flexibility: Current capability and importance in 3 years.
Current Capability 5 4.5 4 3.5 3 2.5 2 1.5 1 Product mix Production volume Custom orders Change in prod. spec. Delayed differentiation Make/buy decisions Shift manufacture load Scale 1 = significant disadvantage 3 = equivalent capability 5 = strong advantage

Importance in Next 3 Years 5 4.5 4 3.5 3 2.5 2 1.5 1

Product mix

Production volume

Custom orders

Change in prod. spec.

Delayed differentiation

Make/buy decisions

Shift manufac. load

Scale 1 = not important 5 = very important

Indian Leather and Footwear sector

Adoption of technologies that aid material and information flow is low in leather sector in India. Less than 50% of the firms have an enterprise application (ERP) for transaction processing and management information.One of the primary reasons could be the size of investments involved in implementation and maintenance which could be prohibitive for the firms in this industry given their size Technology: implementation and benefit
% of companies with some to extensive implementation 100.% 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% PDM/PLM EDI Trading Exchanges e Procurement ERP Demand planning APS QMS WMS TMS CRM Also, most of the firms do not measure basic parameters for competitiveness like Profitability of various SKUs Manufacturing non-conformance rate Outbound freight cost, etc.

Indian Leather and Footwear sector

50

Supporting Industries

Proximity of the industries/information flow

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51

Numerous leather associations act as a bridge between industry and government, academic & research institutions China has a well developed components and machinery industry. In 2006, Wenzhou cluster alone had: 200 footwear machinery manufacturers 380 footwear sole manufacturers 180 footwear last manufacturers 100 footwear accessories and ornaments manufacturers 50 design studios and numerous training schools China Leather Industry Association (CLIA) has developed and registered a trademark called Genuine Leather Mark (GLM) which is internationally accepted There are numerous associations for leather sector in various provinces in China which acts as a bridge between industry and government, communicating the industry's interests to officials so that they are taken into consideration when industrial policies and economic plans are formulated. These associations are envisaged to be a major contact point with academic and research institutions, to help the industry identify and groom the right management and technical personnel. A majority of the large firms in China have internal design centers. Enterprises with a total investment of over Rmb 5 mn are usually equipped with in-house product and technology design, as well as quality control teams. Many of them even appoint foreign and domestic experts as well as academic and research institutions to provide technical advice and product development services. Supporting industries like equipment and footwear components industry are not well developed in India leading to dependence on import for the same

Footwear Components Industry: The size of footwear component industry (which produces components like ornaments, buckles etc) is very small in India. The components industry is completely de-reserved since 2008. However, most of the companies still operate in the small scale levels and the capacity addition has been very limited. Large quantities of footwear components have to be imported from China. This is explained as one of main reasons for India focusing more on mens footwear while China and other competing countries export more womens footwear Demand for womens footwear consumption is driven by higher per capita usage in the developed countries as compared to men. The per capita consumption is 4~5 pairs per woman compared to 2 pairs per man in the developed countries. Equipment Suppliers: Almost all the machines used for leather processing are imported. Local manufacturers are perceived to produce poor quality machines. Given the high cost of imported machinery only large sized firms access them leaving a majority of the leather industry using outdated / poor quality local machines Chemical Companies: Chemical companies play an important role in process changes. Most of the worlds leading producers of tannery chemicals are present in India and have facilities in major clusters (where specific processes to meet the requirement of client tanneries are developed). These companies provided important technical support when Indian tanneries were faced with the task of substituting hazardous chemicals (PCP and Azo dyes).
Source: Indian Leather Industry Prospects and Problems CLE, Anecdotal evidences from Indian Footwear Components Manufacturers Association , Barriers and Opportunities for Promoting Trade in Environmentally Friendly Products- A Study of Indias Leather Industry May 2002

Source: http://info.hktdc.com/imn/02100301/leather003.htm accessed on 18.09.08

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Institutions like CLRI and CLE have been instrumental in the growth of Indian leather industry. However, there is a felt need for more training institutions to meet the export targets by 2011. Organization Central Leather Research Institute (CLRI) Roles Leather-related research, dissemination of new practices and training, testing, and certification facilities to firms Memorandum of understanding with the University of Northampton in the United Kingdom to explore new areas of research in leather Played a key role in setting up CETPs during the shutting down of all tanneries and tackle the problem of AZO and PCP dyes ban by Germany during 90s Council for Leather Exports (CLE) Footwear Design and Development Institute (FDDI) All India Skin and Hide Tanning and Merchants Association and numerous other associations Polytechnics and ITIs providing training in leather and Footwear manufacturing Promote leather exports, gather and disseminate market information to the industry, to run trade shows abroad Train the professional manpower for the industry, Industrial Consultancy, Research and Development and Training of industry professionals Major association of leather and footwear manufacturers who act as a bridge between the Government, CLE and the members Large number of polytechnics and ITIs provide training. However, given the demand for skilled labor there exists a shortage of the same necessitating more training institutions

Factor Condition Supporting Industries

Importance

China

India

Source: Indian Leather Industry Prospects and Problems CLE, Anecdotal evidences, Barriers and Opportunities for Promoting Trade in Environmentally Friendly Products- A Study of Indias Leather Industry May 2002

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Government Support

Economic reforms & Incentives Other policies towards FIEs

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Reforms, Incentives and Policies Chinese government favored FIEs with their flexible policies, reduced tax structure which helped in FIEs gaining more share in the export of leather products. Special preference treatment to Hong Kong, Chinese and Taiwanese to travel and invest in China (More than 60% of the foreign investment in China between 1992 and 1998 is by Hong Kong and Taiwan investors) 2 years tax exemption for FIE from the date they make profit and 50% tax for the next 3 years In the Export Processing Zones, Corporate tax was only 15% while tax rate at other places was 55% for domestic firms and 40% for FIEs. For the promotion of exports, additional 10% tax exemption is provided for firms which export more than 70% of its products Export tax refund of 15~17% for leather products till 2004 and 13% till 30-June-2007 Direct financial subsidies for Research and Development (R&D) expenditure on specified Science and Technology (S&T) projects have increasingly become an instrument of industrial policy.

Five connections and one leveling Connecting roads, Telecommunications, Water, Electricity and Ports and leveling of sites were the main methods used to attract foreign investment Free or highly subsidized land Normally the land is sold at a cost less than the development cost. In most of the local government controlled areas it was close to zero Subsidies for electricity and other utilities Building of roads and other infrastructure projects supporting the factory sites, if necessary Streamlining of government structures and procedures Delegation to local authorities the power to approve foreign investment One - stop shopping centre for getting all approvals within a few days for foreign investment into China
Source: Developing Countries, China and Economic Institutions, 2000, Bargaining Power and Foreign Direct Investment in China: Can 1.3 Billion Consumers Tame the Multinationals? August 2002, The Mixed Reforms A generalization and comparative case study on the ETRE systems of China and the EU 2005, The China Circle Economics and Technology in The PRC, Taiwan and Hong Kong Naughton, 1997

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Reservation of the sector for SSI led to fragmentation of the industry preventing the achievement of economies of scale. The dereservation in 2001 and 100% FDI is expected to bring scale economies in the leather industry During 1950s and 1960s, Indias policies were aimed at employment generation and foreign exchange while reserving the sector for small and medium enterprises. Government constituted a commission in 1972 to examine ways to improve the leather sector The commission recommended the restrictions of exporting semi-finished leather and promote exports of value added leather products The government imposed export tax on the export of semi-finished leather First phase of modernization: took place from 1973 to 1980 with number of incentives and support programs A cash compensatory scheme to compensate Indian exporters for the export disadvantages they faced vis--vis their competitors abroad (South Korean Taiwan, Latin America)with respect to high interest rates, high income tax and taxes on imports The government also provided an airfreight subsidy of 15-22% on leather exports, excise duty exemption for exports of final products, and a duty drawback scheme that paid back firms excise and customs duties paid on the import of raw materials (such as components, packaging materials, etc) used in the manufacture and export of finished products

Second phase of modernization: from 1979 In 1979, the Kaul commission recommended to reduce import duties on all tannery, finishing, footwear, and other leather goods machinery to an uniform rate of 25%. In the mid-1980s, upon the recommendation of the Pande Commission, the government removed all duties on the import of hides and skins, wet blue and crust leather Third Phase: after 2000 De-reservation and De-licensing of several leather goods from the Small Scale sector in 2001 Duty Drawback scheme, 3% Duty Free Import Scheme, Export Credit Passbook (ECPB) and various other schemes 100% FDI allowed in leather and footwear sector from 2002 Focus Markets and Focus Products scheme ( cash back of 2.5% of the FOB value of the products exported to the markets / cash back of 2.5% of the export FOB value to the fifty percent of export turn-over of notified products)

Source: CLE website, Trade Liberalization and the Restructuring of Tamil Nadus Leather Sector: Coping with liberalizations New Environmental Challenges and Lessons from Prior Episodes of Adjustment - 2001

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The Government of India is supporting the leather industry in enhancing its competitiveness through upgradation and modernization by providing financial assistance Department of Industrial Policy and Promotion (DIPP ) provides a comprehensive scheme for modernization and technology up gradation in all the segments of the Leather Industry, from tanneries, footwear, footwear components, saddlery, leather goods and garments. This scheme is called Integrated Development of Leather Sector (IDLS). It was started in 2002 and will be continued till 2012. Government had sanctioned Rs 290 Crores for this project and will be implemented through two Program Implementation Units (PIU) namely CLRI and FDDI. Here, financial assistance will be provided to the extent of 30% of the cost of plant and machinery for SSI and 20% of cost of plant & machinery for other units (i.e. non-small scale units) subject to a ceiling of Rs. 50 lakh for both categories for technology up-gradation/modernization and/or expansion.

Factor Condition Government Support

Importance

China

India

Source: CLE website, CLRI Website, Trade Liberalization and the Restructuring of Tamil Nadus Leather Sector: Coping with liberalizations New Environmental Challenges and Lessons from Prior Episodes of Adjustment - 2001

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India scores better than China on costs of labor. In other key factors like infrastructure, cluster based approach and the presence of supporting industries India needs to bridge the gap. Elements of Diamond Framework

Parameterss Labor Cost Infrastructure

Importance

China

India

Factor Conditions Access to Capital Raw Material Availability Demand Condition Access to Market Management Structure Firm Structure and Rivalry Cluster Based Approach & Collaboration Supporting Industries Government Support Presence of supporting Economic Reforms & Incentives

Strong

Weak

Positive

Neutral

Negative

The CLE had set an export target of USD 7 bn by 2011. Based on current growth rates and segment contributions, exports would be able to reach a target of USD 5.2 bn in the year 2011, a shortfall of about 25% in the next 3 years. 2006-07 Finished Leather Footwear Footwear Components Leather Garments Leather Goods Saddlery and Harness Total (mn $) Source: CLE data 724 1017.07 219.84 309.91 706.28 82.33 3059.43 2007-08 766.93 1209.72 266.11 343.99 784.95 105.81 3477.51

The growth rate for the projection is assumed as the growth rates observed between the year 2007-08 vs. 2006-07

Growth % YoY 5.93% 18.94% 21.05% 11.00% 11.14% 28.52%

2008-09 812.41 1438.86 322.12 381.82 872.38 135.99 3963.57

2009-10 860.58 1711.41 389.92 423.81 969.55 174.77 4530.03

2010-11 911.61 2035.57 471.98 470.41 1077.55 224.61 5191.73

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Scenario Analysis Scenario1: Meeting the export targets with the current composition of the portfolio If the export target for the year 2011 are to be achieved with the share of sub-segments being maintained, growth rates required are between 20 % and 30% for Current composition Finished Leather Footwear Footwear Components Leather Garments Leather Goods Saddlery and Harness Total (Mn $)
Source: CLE data

all sectors. Currently, other than saddlery and harness which accounts for only 2.7% of the export share, all other segments have a growth rate less than 20%. Hence, to achieve the target for the year 2011, several interventions at the policy, sectoral and firm levels are required. Current Growth rate 5.93% 18.94% 21.05% 11.00% 11.14% 28.52% Projected Growth rate 29.3% 24.4% 23.6% 27.3% 27.2% 21.2% 2008-09 991.37 1504.50 329.02 437.79 998.56 128.24 4389.48 2009-10 1281.49 1871.12 406.81 557.16 1270.29 155.42 5542.30 2010-11 1656.52 2327.06 503.00 709.08 1615.97 188.37 7000.00

2007-08 766.93 1209.72 266.11 343.99 784.95 105.81 3477.51

23.7% 33.2% 7.2% 10.1% 23.1% 2.7%

Scenario2: Meeting the export target with 45% share of leather footwear and 15% of finished leather In Indias current exports, finished leather accounts for 23.7% whereas in global trade it is only 16% Similarly, footwear exports constitutes about 33.2 % of Indian exports, whereas in global trade its around 66% Formal and dress shoes dominate Indian exports, while the global trend is towards casual and comfort shoes Proposed composition Finished Leather Footwear Footwear Components Leather Garments Leather Goods Saddlery and Harness Total (Mn $)
Source: CLE data

India produces more men shoes whereas women and children shoes is the bigger market It is assumed that footwear exports increases to 45% in the next 3 years and finished leather exports reduced to 15% of the total exports inline with the global trends In this case, the growth rates required for footwear and finished leather are 37% and 11% respectively which requires large capacity additions and interventions from the government

2007-08 766.93 1209.72 266.11 343.99 784.95 105.81 3477.51

Current Growth rate 5.93% 18.94% 21.05% 11.00% 11.14% 28.52%

Projected Growth rate 11.0% 37.6% 22.6% 26.7% 21.3% 25.7%

2008-09 851.60 1664.28 326.17 435.91 951.93 132.97 4362.85

2009-10 945.61 2289.65 399.78 552.39 1154.43 167.10 5508.96

2010-11 1050.00 3150.00 490.00 700.00 1400.00 210.00 7000.00

15.0% 45.0% 7.0% 10.0% 20.0% 3.0%

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Leather industry requires an investment of over Rs. 7000 Crores to meet the export target of USD 7bn by 2011 set by CLE. It also needs to add nearly 5 lakh jobs to meet the target There is a potential for adding over 5 lakh employees in this sector in the next few years. The potential for employment is across all skills: semi-skilled and unskilled laborers - 92%; technical supervisors- 7%; entrepreneurs, senior managers and technologists - 1%. Sector Tannery Footwear Leather Garments Leather Goods Required Manpower Addition (Nos) 100000 300000 45000 52000 Required Investment (Rs. Crores) 4000 3000 162 130

Source: CII, Indian Leather Exports Prospects and Problems - CLE Anecdotal references

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Key conclusions and recommendations

Improving cost competitiveness through value chain efficiencies: Implementing best practices at a firm level and at the sectoral level through cluster based approach, setting up cross-industry clusters and support them through governmental interventions on infrastructure like port clearances and power. Promoting footwear component clusters near leather clusters: Promotion of footwear component industries near the leather and footwear clusters or incentives for building scale for the component industries would boost the leather sector. Focus on Training: Increasing the capacity of training institutes The existing capacities of the training institutes would not be sufficient to meet the employment generation projections for 2011. Increasing the tanning capacity : Indias current capacity of tanneries is around 2 bn square feet whereas to achieve the export target of 7 bn $ in 2011, around 4 bn square feet of finished leather is required. Attracting Foreign Direct Investment: The leather and footwear sector had seen only Rs. 200 Crores of FDI (Which is only 0.15% of Indias total FDI from 1991 to 2005). FDI brings in scale, efficiency in operations and latest management practices for the industry to benefit.

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Improving cost competitiveness through value chain efficiencies:

Initiative Promoting a cluster based approach among the companies. Organizations can be grouped into small teams within and across regions Ideally, one or two organizations can be aligned to a cluster in a mature industry like automotive/auto component and learn from the leaders in planned cost declines and efficiencies. These organizations can then be leaders who disseminate the learnings to other members through leather specific clusters Implementations of best practices in manufacturing technologies (value engineering) and manufacturing (lean manufacturing, costing systems etc.) Promoting visits by leaders of cluster organizations to other industries to understand management and financial practices Simplify clearance procedures for leather products in the Seaports and Airports

Likely Stakeholders CII, CLE, UNIDO and companies in the clusters

Expected Results Easy transfer of the best practices among the companies which improves their operational efficiencies, costs and collaboration with customers and suppliers Organizations like UNIDO are conducting programs specifically targeted at the leather sector with initiatives like cluster twinning programs where best practices of the global leather industry ( in this case - Italian) are disseminated to the companies in the leather sector ( CLE Leathers June 2008)

UNIDO, CII supported by CLRI, CLE

Operational performance of the companies will improve which results in better quality and delivery

UNIDO, CLE and Industry Associations

Adoption of best practices from other industries helps in improving operational and financial efficiency

State Level Industries Department, Customs department, CLE

Adherence to delivery schedules by the companies results in higher customer satisfaction

Improving cost competitiveness through value chain efficiencies: Learning from the Auto Cluster of UNIDO The objective of the program is to strengthen the capacity of Indian small and medium auto component suppliers to meet the requirements of vehicle manufacturers and, to enhance their productivity and performance levels so as to facilitate their inclusion in the domestic as well as the global automotive supply chains.

Phase 1 of the programme was taken up in 1999 in the western region as a demonstration programme in which 20 companies participated. About 40 companies took part in Phase 2 ( 2003-2005), and the programme now in Phase 3 has 58 companies participating across the country.

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 One cluster comprises 8 to 10 companies. Grouping is dependent upon the geographical location of the companies selected, and for each cluster, national engineers (counselors) having expertise in TPM/TQM etc are appointed, working under the guidance of senior counselors and industry experts. The national engineer visits the companies and helps translate the training inputs. In-plant training and shopfloor interventions are provided in the following modules: employee involvement (Kaizens Q circles, safety); 5S (maintenance of model machine, daily management discipline, waste elimination); quality management (Poka Yoke, process capability, standards); inventory management (containerization, SMED, red tag); productivity improvement ( multi-machine manufacturing, flow manufacturing); and sustenance (alignment with cluster activities). Data on key performance indicators pertaining to quality, cost and delivery is presented by member firms at the periodic review meetings and compared against the baseline survey

These indicators are defects in parts per million (ppm), labor and overall productivity, inventory turnover, delivery schedule achievement, space utilization, etc. According to the counselors, a substantial difference is noticed within a year, or even within a few months. The benefits are also in terms of the reduction of energy, wastage, absenteeism, lead-time for production. The benefits of the programme are seen in a) reduction in absenteeism, b) improvements in work place and work practices, c) total employee involvement, d) reduction in number of accidents, e) decline in in-house rejections, f) reduction in customer returns, g) reduced inventory levels, h) reduction in set up time, i) fewer machine breakdowns, and j) improvement in productivity. According to Automotive Component Manufacturers Association, the intangible benefits have been even higher measured in terms of a clean working environment, improved relations between the management and employees, transformation in work culture, openness and the desire to learn and share, and trust and respect for each other.
Source: Learning, Innovation and Competence Building in SMEs: The Case of Indian Automotives Neelam Singh UNIDO

The benefits of the programme are seen in a) reduction in absenteeism, b) improvements in work place and work practices, c) total employee involvement, d) reduction in number of accidents, e) decline in in-house rejections, f) reduction in customer returns, g) reduced inventory levels, h) reduction in set up time, i) fewer machine breakdowns, and j) improvement in productivity.

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Promoting footwear component clusters near leather clusters:

Initiative Promoting footwear component clusters near leather clusters

Likely Stakeholders Government of India, CLE, companies

Expected Results Cluster based approach can be organized for components also. Incentives can be provided for the component industries to add capacities resulting in increase in economies of scale / consolidation of the industry Focus on womens footwear: Availability of components will allow Indian companies to focus on womens footwear which is the larger market compared to mens footwear

Focus on Training : Increasing the capacity of training institutes and enable training by organizations

Initiative Increase the capacity / number of training institutions in the leather and footwear sector Specific training and certifications in the hot skill areas of toe lasting, cutting etc

Likely Stakeholders Government of India, CLRI, FDDI etc CLRI, Industry Associations

Expected Results Trained personnel to fulfill the projected demand of 5 lakh jobs To reduce the shortage in skilled operations which provide the desired value addition and product premium Companies will provide more training to the employees which leads to improvement in quality, productivity etc

To enable fair labour practices, costs of certifications like SA 8000 which also enables access to key customers and markets and associated costs of training by the organizations can be subsidized with a ceiling linked to the number of employees Training centers in the clusters. Skilled and Semi-skilled operations

State level Industries Department, CLRI

CLRI, CLE and companies in the cluster

Training centers in the clusters can disseminate latest product requirements and can provide trained manpower to the necessary companies

Common standards in all areas of manufacturing can be implemented in a phased manner. E.g. norms of production, common salary levels in a cluster E.g. Following a common salary band in a cluster would help in reducing the attrition. One of the reasons for high attrition levels is the significant difference in salaries between various companies in the same area for the same job (e.g. cutting, stitching etc)

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Increasing the tanning capacity:

Initiative

Likely Stakeholders

Expected Results Increases the availability of finished leather to meet the export target for 2011 Increased motivation for modernization thereby improving efficiencies and building scale

Providing financial assistance/ CLRI, UNIDO and State Level subsidies (over current levels) to Industries Department modernize the existing tanneries and thereby building scale Incentivsing environment friendly State Governments initiatives to promote modernization and enabling cost competitiveness: For example, cost of treating the wastewater can be subsidized to the tanneries with conditions to upgrade the machinery

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Attracting Foreign Direct Investment: Initiative Leather parks with all amenities constituting only export organizations to be initiated Likely Stakeholders Government of India / state governments Expected Results Foreign companies bring in market access and efficiencies of scale and scope. They in turn force Indian companies to improve their operational efficiencies. The dynamics of the industry would therefore undergo a change: Consolidation: There may be a consolidation of the companies which brings Collaboration: Collaborative approach between the players to improve cost competitiveness Tax benefits and incentives in line with global competitors (like China) to be provided to enable FDI Government of India / state governments

Assist Indian companies in identifying partners Government of India of choice for strategic partnerships

In the short term: Typical steps to be undertaken by the firms to survive the downturn Some of the strategies followed by the companies to survive / mitigate the risks in the downturn are: Optimize manufacturing and supply chain networks

Reduce material costs through sourcing strategies Variabilize cost structure through tolling and outsourcing Challenge value contribution of each business unit and plan accordingly Rethink the operating model to reduce cost and business complexity

Some of the methods of reducing costs are listed below: Tactical Improvements Cost Imrovement levers Spend reduction and Demand management Business Process Redesign Infrastructure Rationalization Service Delivery Model and organization Alignment Business Model Redesign Description Focuses on strategic sourcing, demand management, and tax management to aggressively reduce external spend % savings* 10-20%

Focus on streamlining business processes via simplification, 5-10% elimination, or outsourcing Focus on IT and real Estate portfolios, projects, platforms, and support rationalization Focuses on re-aligning staff based on method of adding value and realtionship to business Shift to a more cost-efficient business model 15-25%

10-30%

Strategic, Structural Improvements

20-30%

* relative savings estimates based on Deloitte experience.

Source: Deloitte Research 66

Annexure: "Results of the Primary Survey"

Primary Survey The responses from 12 companies (as detailed in the terms of reference) were collected in the primary survey Indias leather clusters are present in South, North and East zones which together total 87% of the manufacturing facilities in India. The Central and West zones together contribute only 13% of the total number of units. Hence, the distribution for the study focused significantly on the South, North and East zones. Sector Tannery Footwear / Footwear components Leather goods Leather Garments Saddlery and Harness No. of Companies 3 6 1 1 1 Annual Revenue (Rs. Crores) <20 21 50 51 - 100 101 - 200 >200 No. of Companies 2 4 4 1 1

Region South North West East

No. of Companies 6 3 1 2

Approximate number of employees <100 101-500 501 1000 >1000

No. of Companies 1 4 5 2

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Business performance Supply chain priorities Collaboration Visibility Flexibility Product innovation Operational excellence Human resources Infrastructure

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Business Performance Industry growth rate, new geographic markets and new products are expected to drive revenue for Indian leather industry in the immediate future. JVs and M&A are seen as the next set of drivers Revenue growth drivers - next 3 years
5 4.5 4 3.5 3 2.5 2 1.5 1 Industry growth rate Economy New geographic markets New market channels New products / services Joint ventures / alliances Merger / acquisition

Indian Leather and Footwear sector

Scale 1 = not important 5 = highly important

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Most of the Indian companies performed well in shareholders return, revenue growth, Customer satisfaction and retention of customers. This is also reflected by the fact that Indian exports exceeded the target set for the year 2007-08 by 14% Business performance metrics
Performance against goals 5 4.5 4 3.5 3 2.5 2 1.5 1 Return to shareholders Revenue growth Market share Profitability ROA Customer satisfaction Customer loyalty Scale 1 = Poor Performance 3 =met goals 5 = Exceptional Performance

Indian Leather and Footwear sector

The profitability of Indian companies were lower due to rising labour costs and input costs. Profitability of 50% of the companies were 5% or less Profitability
Regional Profitability 60.%

50.%

40.%

30.%

20.%

10.% Peer group distribution of profitability percentage: EBIT (earnings before interest and taxes) in last fiscal year.

.% Negative (net loss) Break Even (no profit/no loss) Up to 5% profit 5-10% profit 10-15% profit 15-25% profit Over 25% profit

Indian Leather and Footwear sector 70

Supply Chain Priorities Improving Customer service, manufacturing lead time and productivity and time-to-market seems to be the key priorities of Indian companies.
Supply Chain Priorities 5 4.5 4 3.5 3 2.5 2 1.5 1 Product innovation Time-tomarket Sourcing Quality ManufaManufaManufacturing cturing cturing flexibility productivity lead time / cost Logistics Customer Supply service chain cost Scale 1 = not important 5 = highly important

Indian Leather and Footwear sector

Adoption of technologies that aid material and information flow is low in leather sector in India. Less than 50% of the firms have an enterprise application (ERP) for transaction processing and management information.One of the primary reasons could be the size of investments involved in implementation and maintenance which could be prohibitive for the firms in this industry given their size Technology: implementation and benefit
% of companies with some to extensive implementation 100.% 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% PDM/ PLM EDI Trading Procurement Exchanges ERP Demand planning APS QMS WMS TMS CRM Profitability of various SKUs Manufacturing non-conformance rate Outbound freight cost, etc. Also, most of the firms do not measure basic parameters for competitiveness like

Indian Leather and Footwear sector August 2009 71

Collaboration Less than 50% of the organizations surveyed collaborate with the customers on tactical areas like demand planning, transportation planning and production planning initiatives. Organizations who collaborate with customers have reported benefits Customer collaboration and benefits achieved
% of companies with medium to high collaboration 100.% 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement

Benefits Gained 5 4.5 4 3.5 3 2.5 2 1.5 1 Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit

Indian Leather and Footwear sector

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Similarly, only about 50% of the companies surveyed have engaged in a collaboration with suppliers. However, they have not achieved significant benefits. These levels of collaboration have resulted in delayed deliveries from suppliers. Less than 20% of the companies reported on-time deliveries of over 70% from suppliers Supplier collaboration and benefits achieved
% of companies with medium to high collaboration 100.% 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement

Scale 1 = significant disadvantage 3 = equivalent capability 5 = strong advantage

Benefits Gained 5 4.5 4 3.5 3 2.5 2 1.5 1 Strategic planning Demand planning Promotion planning Production planning Inventory replenishment Transportation planning Cost reduction Quality improvement Scale 1 = not important 5 = very important

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Number of on-time deliveries/total number of deliveries (in %)

Industry Supplier Delivery % 60.% 50.% % of companies 40.% 30.% 20.% 10.% .% <50% 50-60% 60-70% % of On time deliveries 70-80% >80% Indian Leather and Footwear sector

Visibility Lack of collaboration with the suppliers and customers has resulted in poor visibility along the supply chain Information availability to understand supply chain performance
5 4.5 4 3.5 3 2.5 2 1.5 1 Delivery dates Supplier inventory Supplier Visibility Indian Leather and Footwear sector Supplier capacity FG Production Inventory schedule Capacity Product cost Product Profit Customer forecast Customer inventory Customer profitability Customer service Customer retention

Internal Visibility Scale 1 = no information available 3 = some information available 5 = information is readily available

Customer Visibility

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Flexibility Due to the poor visibility of the supply chain and low levels of collaborations with in the supply chain, Indian companies have not created capabilities in flexible supply chains. Organizations have not indicated capabilities in concepts like delayed differentiation, make/buy decisions and abilities to rapidly change product mix and volumes Flexibility: Current capability and importance in 3 years.
Current Capabilities 5 4.5 4 3.5 3 2.5 2 1.5 1 Product mix Production volume Custom orders Change in prod. spec. Delayed differentiation Make/buy decisions Shift manufac. load Scale 1 = significant disadvantage 3 = equivalent capability 5 = strong advantage

Importance in Next 3 Years 5 4.5 4 3.5 3 2.5 2 1.5 1 Product mix Production volume Custom orders Change in prod. spec. Delayed differentiation Make/buy decisions Shift manufac. load Scale 1 = significant disadvantage 3 = equivalent capability 5 = strong advantage

Indian Leather and Footwear sector

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Product Innovation Though only a few Indian companies have their own design studios, innovation in developing the product is high. Companies are also focusing on improving their time-to-market capabilities Product innovation: capability and priority
Current Capabilities 5 4.5 4 3.5 3 2.5 2 1.5 1 Product innovation Time-to-market

Innovation Priorities 5 4.5 4 3.5 3 2.5 2 1.5 1 Product innovation Indian Leather and Footwear sector Time-to-market

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Operational Excellence Indian companies show implementation of major functions like forecasting, order management, manufacturing etc. But only a few companies are investing in operational excellence in R&D. Those who have invested have achieved higher benefits Operational excellence: functional focus and benefits achieved

% with Some to Major Implementation 100.% 90.% % of companies responded 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Forecast Sales & Marketing
Order management

Procurement

Manufacturing

Distribution

Supply chain network

R&D

Engineering

Benefit Achieved to Date 5 4.5 4 3.5 3 2.5 2 1.5 1 Sales & Marketing Forecast Order management Procurement Manufacturing Distribution Supply chain network R&D Engineering

Indian Leather and Footwear sector

Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit

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Less than 50% of the companies have implemented customer segmentation, demand planning and lean manufacturing techniques. This low level of implementation results in poor visibility and business performance Operational effectiveness techniques and benefits achieved

% with Some to Major Implementation 100.% 90.% % of companies responded 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Customer segmentation Demand planning Supplier scorecards Design for mfg Lean mfg Continuous improvement Quick changeover

Benefit Achieved to Date 5 4.5 4 3.5 3 2.5 2 1.5 1 Customer segmentation Demand planning Supplier scorecards Design for mfg Lean mfg Continuous improvement Quick changeover

Indian Leather and Footwear sector

Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit

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Though a few companies have obtained quality certifications in ISO, SA8000 etc, process control techniques, TQM were not implemented in most of the companies. These factors affects the companys performance in the areas of quality, inventory holding and therefore cost management Quality management and benefits
% with Some to Major Implementation 100.% 90.% % of companies responded 80.% 70.% 60.% 50.% 40.% 30.% 20.% 10.% .% Design for quality Quality certification SPC TQM Six Sigma

Benefit Achieved to Date 5 4.5 4 3.5 3 2.5 2 1.5 1 Design for quality Quality certification SPC TQM Six Sigma

Indian Leather and Footwear sector Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit

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Very few companies have the plans of outsourcing their manufacturing and logistics. Most of the companies are not planning to implement cost reduction plans like workforce reduction, product rationalization etc. Cost reduction

% with Some to Major Implementation 100.% % of companies responded 90.% 80.% 70.% 60.% 50.% 40.% 30.% 20.% .% Reduce workforce Product rationalization Close Facility Move production Outsource mfg
Outsource logistics Transportation optimization Supply chain network optimization

Benefit Achieved to Date 5 4.5 4 3.5 3 2.5 2 1.5 1 Reduce workforce Product rationalization Close Facility Move production Outsource mfg Outsource logistics Transportation optimization Supply chain network optimization

Indian Leather and Footwear sector Scale 1 = no benefit 3 = moderate benefit 5 = very high benefit

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Due to poor visibility in the value chain (customer and supplier), Indian leather companies are fraught with inefficiencies in terms of higher inventory and delayed deliveries. Given the nature of the industry and export destinations, these typically result in high levels of obsolescence On- time delivery for most of Indian companies is less than 70%
Industry On Time Delivery 60.% 50.% % of Companies 40.% 30.% 20.% 10.% .% <70% 70-80% 80-90% >90% % of on time deliveries Percentage of shipments that meet customer request date (for the different peer groups). Indian Leather and Footwear sector % of Companies

Over 50% of the Indian companies hold 3 6 months stock on an average

Inventory Turns 60.% 50.% 40.% 30.% 20.% 10.% .% <2 2-4 4-6 Inventory Turns (Annual cost of goods sold) / (average total on hand inventory) 6-8 >8

Human Resources There is a high level of attrition in this industry. Most of the companies indicate attrition levels of over 15%. This results in higher costs for training, poor quality and delay in delivery dates Attrition levels in Indian Leather industry
Attrition levels 60.% 50.% 40.% 30.% 20.% 10.% .% >15 % 10-15 % 5-10% < 5%

Infrastructure Nearly 70% of the respondents believe that customs clearance, inland transportation delays and power outages are the key disablers of their competitiveness
% of companies who responded that infrastructure has significant impact 100.% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% .% Customer Clearance delays Multiple responses allowed Source: Primary Survey conducted by Deloitte August 2009 81 Inland Transport delays Power Outages / Cost of own power Water Others

% of Companies

Indian Leather and Footwear sector

List of Abbreviations

AISHTMA APS ASEAN bn CAGR CEO CETP CII CLE CLIA CLRI CRM CSIR DIPP DnB e.g. EDI ERP EU FAO FDDI FDI FDRA GBS IDLS ISO ITC JV LCL

All India Skin and Hide Tanners and Merchants Association Advanced Planning and Scheduling Association of Southeast Asian Nations Billion Compounded Annual Growth Rate Chief Executive Officer Common Effluent Treatment Plant Confederation of Indian Industries Council for Leather Exports China Leather Industries Association Central Leather Research Institute Customer Relationship Management Council of Scientific and Industrial Research Department of Industrial Policy and Promotion Dun and Bradstreet Example Electronic Data Interchange Enterprise Resource Planning European Union Food and Agricultural Organization Footwear Design and Development Institute Foreign Direct Investment Footwear Distributors and Retailers of America Global Manufacturing Benchmarking Survey Integrated Development of Leather Sector International Organization for Standards International Trade Center Joint Venture Labour Contract Law

LVMH mn NGO NIFT NMCC PDM PETA PIU PLM QMS R&D ROA Rs. SA8000 SEZ SME SPC sqm SSI TMS TQM UAE UK UNIDO US USA USD WMS WTO

Louis Vuitton Moet Hennessy Million Non-Governmental Organization National Institute of Fashion Technology National Manufacturing Competitiveness Council Product Data Management People for Ethical Treatment to Animals Program Implementation Units Product Lifecycle Management Quality Management System Research and Development Return on Assets Indian Rupees Social Accountability 8000 Special Economic Zone Small and Medium Enterprises Statistical Process Control Square Meter Small Scale Industries Transportation Management System Total Quality Management United Arab Emirates United Kingdom United Nations Industrial Development Organization United States of America United States of America United States Dollar Warehouse Management System World Trade Organization

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Contacts

August 2009

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In this material Deloitte refers to Deloitte Touche Tohmatsu India Private Limited (DTTIPL), a Company established under the Indian Companies Act, 1956, as amended. DTTIPL is the member firm of Deloitte Touche Tohmatsu, a Swiss Verein, whose member firms are legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its member firms. These materials and the information contained herein are provided by DTTIPL and are intended to provide general information on a particular subject or subjects and are not an exhaustive treatment of such subject(s). Further, the views and opinions expressed herein are the subjective views and opinions of DTTIPL based on such parameters and analyses which in its opinion are relevant to the subject. DTTIPL makes no express or implied representations or warranties regarding these materials or the information contained therein. While due care has been taken to ensure the accuracy of the information contained herein, no warranty, express or implied, is being made, by DTTIPL as regards the accuracy and adequacy of the information contained herein. The information in these materials is not intended to constitute accounting, tax, legal, investment, consulting, or other professional advice or services. The information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action that might affect your personal finances or business, you should consult a qualified professional adviser. Your use of these materials and information contained therein is at your own risk, and you assume full responsibility and risk of loss resulting from the use thereof. DTTIPL will not be liable for any special, indirect, incidental, consequential, or punitive damages or any other damages whatsoever, whether in an action of contract, statute, tort (including, without limitation, negligence), or otherwise, relating to the use of these materials or the information contained therein. If any of the foregoing is not fully enforceable for any reason, the remainder shall nonetheless continue to apply. 2009 Deloitte Touche Tohmatsu India Private Limited